One peculiar aspect of American tax law is that getting married can dramatically affect a couple's total tax bill. Many couples, especially those in which one person earns the vast majority of the couple's income, benefit from the tax treatment on married couples. But many others, especially two-income families where each spouse's earnings are roughly equivalent, can end up paying a whole lot more in tax -- a phenomenon known as the marriage penalty.
The tax compromise that lawmakers agreed to at the beginning of 2013 made several substantial changes to the tax laws, and a few of those changes actually made the marriage penalty worse for some couples, especially high-income couples where both spouses work and have considerable income. Let's look at these three provisions and how much they'll boost the marriage penalty's impact in 2013 and beyond.
1. The new Obamacare tax.
Obamacare created two new taxes: a 0.9% tax on wages and other earned income for high-income earners, and a 3.8% tax on investment income. For both taxes, the threshold is $200,000 for single filers and $250,000 for married couples.
So if two single people each earned $200,000, they wouldn't be subject to the Obamacare tax at all. But if they got married, then $150,000 of their total income of $400,000 would get taxed, with an additional tax liability of $1,350. Similar situations with investment income could lead to a much larger marriage penalty, as the investment tax rate is more than quadruple the rate for wages. Investors in dividend-oriented ETFs Vanguard High Dividend Yield (VYM -0.04%), SPDR S&P Dividend (SDY 0.21%), and iShares DJ Select Dividend (DVY -0.25%) should therefore take care to consider tax-favored investment vehicles for their investments.
2. New high-income tax brackets.
The marriage penalty has existed in tax brackets for a long time. The bottom two tax brackets don't include a marriage penalty, as they're designed so that the amount of income married couples can earn is exactly twice what singles can earn to stay within a given bracket. But for the 25% tax brackets and above, the married brackets kick in at far less than twice the single amounts, with the 35% bracket kicking in at exactly the same amount for singles and couples.
The tax compromise created a new 39.6% bracket that kicks in for high-income taxpayers. The way the law was drafted, that 39.6% rate applies to single filers making more than $400,000 and joint filers with income above $450,000. What that means is that if two unmarried people each make $400,000, they won't be subject to the new provision, with taxes topping out at 35%. But if those two people get married, then an additional $350,000 in income will get taxed at the higher rate. In this example, a couple would pay more than $16,000 in additional taxes solely because of the marriage penalty in the tax brackets.
Similar provisions affect capital gains tax rates, with a higher 20% maximum rate applying above the income threshold compared with 15% below it. With the S&P 500 (^GSPC -0.12%) having set record highs during the past week, capital gains could be substantial for those selling off or rebalancing holdings in their portfolios.
3. Reductions in itemized deductions and personal exemptions.
The tax compromise brings back provisions that reduce the amount that high-income taxpayers can deduct for personal exemption allowances and on itemized deductions. Again, the thresholds at which these provisions kick in include a marriage penalty, with singles above $250,000 of adjusted gross income and couples over $300,000 not being able to reduce their taxable income by the full amount of their exemptions and deductions.
Here, the impact of the marriage penalty could mean that every penny of personal exemptions is taken away, even if none of them would be removed if the couple remained unmarried. Similarly, reductions in itemized deductions could increase their tax bill by more than $2,375 at top rates.
Why a marriage penalty?
The policy reason put forth for allowing a marriage penalty tends to be that couples can live more cheaply than singles. But with no rules preventing unmarried taxpayers from living together and reaping the same living-cost savings, it'll be interesting to see how many couples choose not to tie the knot in order to save on their tax bills going forward.